A manager believes his firm will earn a 15 percent return next year. His firm has a beta of 2.1, the expected return on the market is 6 percent, and the risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued.

Question

Quizplus · Accepted Answer

The correct answer is A because the expected return on the firm should be 10.4 percent, which is less than the 15 percent return that the manager believes the firm will earn. This indicates that the manager believes the firm is undervalued.

A Manager Believes His Firm Will Earn a 15 Percent